Debt ratings convey information primarily to debt

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Debt ratings convey information primarily to debt investors who are interested in assessing probability that the borrower will make interest and principal payments on time. If a comp _ defaults on its debt, debt holders seek legal remedies, including forcing the borrower to liqui its assets to settle obligations. However, in forced liquidations, debt holders rarely realize entire amounts owed to them. It's important to bear in mind that debt ratings are opinions. Rating agencies use sev financial ratios to assess default risk. A partial listing of ratios utilized by Moody's, together wi median averages for various ratings, is in Exhibit 7.6. In examining the ratios, recall that debt increasingly more risky as we move from the first row, Aaa, to the last, C. 7-23 Module 7 I Liability Recognition and Nonowner Financing ANALYSIS DECISION You Are the Vice President of Finance --- -- Your company is currently rated B1/B+ by the Moody's and S&P credit rating agencies, respeo- tively. You are considering restructuring to increase your company's credit rating. What types - restructurings might you consider? What benefits will your company receive from those restruc ings? What costs will your company incur to implement such restructurings? [Answer,p. 7-33] What Determines Credit Ratings? Verizon bonds are rated A3,A-, and Aby Moody's, S&P, and Fitch, respectively, as of2010. It- this rating, in conjunction with the maturity of Verizon's bonds, that establishes the market in est rate and the bonds' selling price. There are a number of considerations that affect the rating a bond. Standard & Poor's lists the following factors, categorized by business risk and finan risk, among its credit rating criteria: Business Risk Industry characteristics Competitive position (marketing, technology, efficiency, regulation) Management Financial Risk Financial characteristics Financial policy Profitability Capital structure Cash flow protection Financial flexibility Ratio Values for Different Risk Classes of Corporate Debt* - EBITAI EBITAI EBITA Oper (FFO + Int FFO/ RCF/Net Debt! Debt! CAP AvgAT Int Exp Margin Margin Exp)lInt Exp Debt Debt EBITDA Book Cap Dep - ~ __ ~~i5. __ ~'!IF'li!Ii - --- - Aaa ...... 20.6% 25.6 24.9% 22.8% 23.8 129.5% 83.2% 0.7 20.7% 1.2 Aa ....... 12.6% 12.5 21.6% 20.5% 13.6 51.8% 39.4% 1.6 39.3% 1.2 A ........ 11.8% 7.5 15.0% 14.9% 8.3 40.2% 30.7% 1.9 43.7% 1.0 Baa ...... 9.0% 4.4 13.1% 12.4% 6.1 27.4% 26.6% 2.7 45.4% 1.1 Ba ....... 8.3% 3.1 12.4% 10.9% 4.5 22.3% 23.5% 3.3 50.8% 1.1 B ........ 6.6% 1.4 9.1% 7.8% 2.6 11.7% 11.6% 5.1 73.8% 0.9 C ........ 2.3% 0.4 2.8% 3.1% 1.4 3.1% 3.2% 7.7 100.5% 0.7 • Tablereports2010medianvalues;fromMoody'sFinancialMetrics TM, KeyRatiosby ratingandindustryfor NorthAmericannonfinancial corporations:December2010(reproducedwithpermission). EBITNAverage Assets EBITNlnterest Expense EBITA Margin Operating Margin (FFO + Interest Exp)/Interest Exp FFO/Debt RCF/Debt Debt/EBITDA Debt/Book Capitalization CAPEXlDepreciation Exp EBITNAverage of Current and Previous Year Assets EBITNlnterest Expense EBITNNet Revenue Operating Profit/Net Revenue (Funds From Operations + Interest Expense)/Interest Expense Funds From Operations/(Short-Tenm Debt + Long-Term Debt) (FFO - Preferred Dividends - Common Dividends - Minority Dividends)/(Short-Term Debt + Long-Term Debt) (Short-Term Debt + Long-Term Debt)/EBITDA (Short-Term Debt + Long-Term
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